By Hema Senanayake –

Hema Senanayake

We are in a mess, so think some economists. They say banks are solvent this time unlike the Great Recession in 2008-2009. During the Great Recession the crisis was complex requiring the government to bailout banks apart from major manufacturing companies. They further say that this time the problem is straight forward which is the containment of virus as banks are solvent. This notion is wrong.

We are in a full-blown crisis. It appears that it is predominantly a health crisis and a problem of broken production and supply chain globally. But the crisis is much deeper. Stock markets are crashing. Values of pension funds invested in stock markets are depreciating. Investors in Asia and Europe move their investment funds to Wall Street which would have resulted in creasing the Indexes at Wall Street under normal circumstances but this time around those Indexes kept plunging, almost 30% down. Global savings just evaporating through Wall Street!

Is the banking system resilient to face the stock market crashes world-wide? Are banks resilient to absorb shocks arising from credit defaults by businesses and consumers? What about the possible sovereign debt defaults by countries like Italy? Already, banks are not making loans. A few days ago, Boeing asked $60 billion from the U.S. Federal government. Watch what is happening in Goldman Sachs, perhaps you may gauge the level of resilience of banks from this single non-banking financial institution. I think, the U.S. president should make a concerted effort with other world leaders to close stock markets temporarily until the curve of the disease infection flattened.  

If the crisis is a mess, then it is going to be bigger and complex one which cannot be resolved by reduction of interest rates, Statutory Reserve Ratio and by another round of Quantitative Easing (a method of pumping money by the Central Bank). Paul Krugman, a Noble Prize-winning economist predicted that the world is drifting into a permanent recession. He might be right or wrong. But I think we must be prepared for the worst.

Still Trump did not say that he is a Keynesian now. But with his actions, he proved that he is a Keynesian. He got both Executive branch and the legislature intervened to manage demand and supply. Towards the end of the last week, President Trump invoked a special piece of Legislative Act known as Defense Production Act. Under the powers of this Act, he (administration) asked General Motors( a car manufacturer) to manufacture respirators, ask another manufacturer of pampers to produce medical grade masks and protective gowns for health care providers and asked alcohol beverage manufacturer to produce hand sanitizers and the list goes on. In fact, he is now a supper Keynesian. If the virus is contained successfully for which we earnestly hope, there will be excess production of certain products but that’s okay.  There is nothing wrong if global leaders act like Keynesians. But to enable them to function as Keynesians, they need to act as Fisherians too. This article is to originate a discussion about it. 

After the Great Depression in 1929-1933 the world learnt two lessons. One is provided by John Maynard Keynes in 1936. His General Theory evolved to dominate macroeconomics later with brief periods of setbacks. In a crisis like this suddenly all become Keynesians. The second lesson was provided in 1936 by Irving Fisher, a great American economist. He insisted that the economy must be founded upon Full Reserve Banking as the Fractional Reserve Banking might lead to create excessive debt bubbles which are bound to crash. He explained that the Great Depression was a direct outcome of Fractional Reserve Banking which is known as the debt-based monetary system.  Many economists agree that the Great Recession too resulted from the same debt-based monetary system.

It is true that the present obstruction of global production and supply chain and the resultant recession is not directly resulted from the debt-based monetary system.  Perhaps such recession could have been a few years away on the timeline. Yet suddenly the world is facing a medical crisis. I observe that Fisher’s proposition for the transition to Full Reserve Banking from present debt-based monetary system is applicable under the current crisis as the said transition could provide an opportunity to create a lot of debt-free money for governments to make their due response for the health crisis without creating any inflation. 

What are the risks of such transition? A few leading economists using mathematical models tried to answer this question in recent times. Using Dynamic Stochastic General Equilibrium (DSGE) models, they have proved that the transition to Full Reserve Banking can be done smoothly. So should be the reversal of it, I think. Japanese economist Prof. Kaoru Yamaguchi is a leading economist who have studied this subject extensively after the Great Recession. Also, in 2012 International Monetary Fund published a Working Paper in which it insisted that above mentioned transition can be done smoothly. Research object of those studies was the U.S. economy.

If the methodology is simplified, the Central Bank would increase the Statutory Reserve Ratio gradually to 100%. As a result, commercial banks will begin to function as intermediaries making loans without being able to create “credit-money”, a virtual money in the system. Hence, the virtual money formerly created by the commercial banks under Fractional Reserve Banking, would be created under a Public Money Policy by the Central Bank now. I think, the plan could be implemented partially and might be reversed gradually when more flexibility is required for the economy, (as new piece of theory does not support for permanent transition to Full Reserve Banking system). Obviously, for those countries which use some other country’s domestic currency as their reserve currency for international payments, this plan could be a prudent plan. 

However, for those countries which hold global reserve currencies, like dollar and euro, this plan could be implemented partially so that those countries would create a lot of debt-free money to be used domestically or within the monetary union and to support the rest of the countries while keeping enough flexibility to serve the world as reserve currencies.

Still American politicians are arguing about finding money. New York Mayor demanded money from the federal government saying that many New Yorkers would die who are not supposed to die if federal government does not act swiftly. Federal government was not quick to pass the stimulus Act which will provide money directly to households, hospitals, cities, local and state governments. This happens, because federal government thinks how much it should be indebted more, they do not think in terms of Fisher’s proposition, a method to create debt-free money. If physical capacity of production to face the health crisis is available or could be made available sooner, money should not be a limited resource. This is an exact time even the U.S. government must explore the possibility of switching from debt-based monetary system to a partial “full reserve banking” system. By definition there is no partial full reserve system, but here partial full reserve banking system is a system in which commercial banks create a lessor amount of “credit money” while the government creates a good amount of debt-free money under a Public Money Policy, not exceeding the system’s requirement.

Let us all be Keynesians and Fisherians to face this severe medical crisis.